Should settlement agreement payments give award break downs

Round two. This case deviates away from employment law and instead focuses on tax law regarding settlement agreements. Before you nod off I would like to add that while the cases we cover in Case of the Week go to court, most claims are resolved out of court via a settlement agreement which is why this case is so significant.

A, the Claimant, was of non-European origin and a trader for a European bank (please note this is not the Respondent). He was supposed to receive an end of year bonus equating to 10% of the profit he made, however, on two occasions his bonus was considerably less despite other European employees receiving the normal amount.

He was verbally promised that his next bonus would make up any shortfall in earnings but before the end of the year the bank was bought out and the Claimant was made aware about possible redundancies.

The Claimant raised grievances about his selection for redundancy and non-payment of owed bonuses which he considered were a breach of contract. The Claimant alleged that his treatment was due to him being non-European. The Claimant was offered a settlement agreement with a £600,000.00 lump sum to settle any claims he might have. He accepted this and subsequently filled in his tax return for that year.

HMRC, the Respondent, examined the tax return and tried to establish the reasoning for the £600k payment. The Respondent asked the bank for a breakdown of the Claimant’s settlement to determine whether any of it was for earnings. The bank stated that the settlement was in relation to the settling of his claims, in particular unpaid bonuses. The Respondent amended the tax return to show the settlement fee as earnings, the Claimant disagreed.

The Tax Tribunal held that a payment made under a settlement agreement cannot amount to remuneration in exchange for the Claimant’s services and thus is not taxable. Whilst bonuses were potentially owed to the Claimant the settlement was in relation to his allegations of racial discrimination and thus being compensated for potential discrimination is not a form of earnings.

The take away point from this case:

Potential litigants do not need to be successful in Tribunal in order to take advantage of the tax status. In this case there was no breakdown of the compensation to state what was paid for each claim so the Tribunal allocated the entire amount to discrimination compensation. In future it may be worth breaking down the nature of any compensation package in settlement agreements. This is a useful case in settlement agreement law but may well be revisited in the future.